Difference Between Performing Loan & Non-Performing Loan

Loan is the amount of money that a bank lends to the customer and collects back both principal and interest. Interest is the profit that bank receive in exchange for lending money to customers. It is the expense for the customers who need to spend in order to use the money. However, some loans are not collectible due to customers’ liquidation.

Debt is the liabilities that company or individual borrows from the bank. The bank will record these amounts as loans in its balance sheet. These are the assets of the bank invest and they expected to collect it back plus the interest.

However, not all loans are going to be collected, some may be gone as the borrowers are bankrupt, so the bank need to write off the loan as bad debt expense.

Performing Loan

Performing loan is the loan that banks expect to collect back from customers as they have paid both principal and interest on time. The last payment of this loan is less than 90 days base on the schedule.  The bank is receiving payment not more than 90 days base on the schedule. It means the borrower may pay late but it is not more than 90 days. We consider that they are making proper payment.

The performing loan shows that the customers are highly likely to pay back the loan and the bank will not facing with bad debt.

Non-Performing Loan

Non-performing loan (NPL) is a bank loan which not expect to be collect in both principal and interest due to late payment. The borrowers are not making proper payment of principal or interest, they are highly likely going to default the loan. Base on the accounting standard, the loan will be considered as non-performing if they are more than 90 day past due. However, the bank may consider the loan as non-performing if they have enough information regarding the borrowers’ bankruptcy.

Non-performing loan is not a good indicator for the bank, it show that customers are having a financial difficulties and may not able to to pay back the loan.

Types of non-performing loans

  1. Interest Delinquency: Interest delinquency occurs when a borrower fails to meet their financial obligations related to interest payments. In this scenario, the borrower may have capitalized the interest, refinanced the loan, or delayed the payment for an extended period, typically surpassing 90 days. When interest payments are consistently missed or postponed, it raises concerns about the borrower’s financial stability and the potential for a more significant default on the loan.
  2. Doubtful Future Payments: This type of NPL arises when a borrower is behind on their loan payments but has not yet crossed the 90-day threshold. Despite the delinquency being less than three months, the lender has reservations about the borrower’s ability to meet future payment obligations. This skepticism may stem from the borrower’s financial indicators, such as declining creditworthiness or adverse changes in their economic situation. The lender, in this case, anticipates a higher risk of default, and the loan is classified as nonperforming.
  3. Maturity Date Default: Maturity date default occurs when the borrower fails to repay the loan principal even after the agreed-upon maturity date has passed. Loans are typically granted with specific terms, including a maturity date by which the borrower must repay the principal amount in full. If the borrower is unable to fulfill this obligation and the unpaid amount extends beyond the maturity date, the loan is classified as nonperforming. This type of NPL signals a more severe breach of the borrowing agreement and requires immediate attention from the lending institution.

Impact of Nonperforming Loans (NPLs) on Banks

Financial Performance:

  • Reduced income: Lost interest payments from NPLs decrease overall profits, impacting the bank’s revenue stream.
  • Limited lending capacity: With funds tied up in nonperforming assets, there is less money available for new loans, affecting the bank’s ability to support economic activities.
  • Increased operating costs: Managing NPLs incurs additional expenses, including legal fees, collection efforts, and administrative overhead, which can weigh on the bank’s financial performance.

Market Impact:

  • Investor disinterest: A high NPL ratio can lead to a lower stock price, discouraging investors who may perceive the bank as risky or poorly managed.
  • Reduced lending options: As NPLs rise, banks may become more conservative in their lending practices, reducing the number of lending opportunities available to potential borrowers and slowing economic growth.

Risk & Stability:

  • Financial instability: High levels of NPLs weaken the overall financial health of the bank, raising concerns about its stability and ability to weather economic downturns.
  • Increased risk of default: If NPLs reach critical levels, the bank itself may struggle to meet its financial obligations, posing a systemic risk to the broader financial system.